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From the September 2008 Issue
Troubles with student loans first surfaced last winter as private lenders began pulling out of the market and nonprofit loan providers suddenly found themselves unable to raise capital. Nine months later, it is clear that the student loan market is the latest to take a hit from the credit crunch that continues to ripple through the economy.
While recent market changes have helped boost liquidity, collection agencies are bracing for the fallout. Placements are expected to rise and liquidations could slow as lenders and schools pressure collectors to trim margins.
Collection agencies may lose lender clients that have dropped out of the student loan market entirely.
At the same time, agencies will be forced to shift their collection strategies as the economy weakens and loan repayments become more difficult for students who graduate and cannot find jobs. "The market is very unsettled," says Lynn Heineman, vice president of sales at Account Control Technology, a collection agency in Canoga Park, Calif. that handles education loans. "The subprime mortgage mess has impacted us."
The student loan market is thought to total an estimated $85 billion annually. Federal and private loans make up the market, which is growing. In the past decade, debt for graduating seniors with student loans has more than doubled to $19,200 from $9,250 – a 108% jump.
About seven million borrowers will need more than $68 billion in federal loans this school year, says the National Association of Student Financial Aid Administrators (NASFAA). By 2011, it is projected that three million new students will be in college. One industry group forecasts the amount borrowed for student loans from 2008 to 2012 will total $500 billion.
Perfect Storm
Even as demand for borrowing rises because of the escalating costs of a college education, the student loan market has been destabilized by a perfect storm of events. The 2007 College Cost Reduction and Access Act (CCRAA) cut subsidies to lenders and the U.S. economy's credit meltdown soon followed.
By May, 72 lenders had suspended participation in the Federal Family Education Loan Program (FFELP), reports the National Association of College & University Business Officers. Four nonprofit state loan agencies dropped all FFELP originations. NASFAA reports that private student loans had been dropped by 13 lenders, including Bank of America. "In my 29 years in higher education, I have not seen conditions like this," says David Glezerman, bursar at Temple University in Philadelphia.
Martin Damian, vice president of guarantor relations at Windham Professionals, a collection agency in Salem, N.H., agrees: "There has never been anything like this."
Damian places some of the blame with lenders that have been unable to find investors to buy bundled student loans because of low return rates. "It's still not the best deal for investors," he says.
Because of worries of a student loan market collapse, Congress in May passed and President Bush signed an emergency bill to make it easier for students to borrow money. The new law raises by $2,000 the amount students can borrow through the federal Stafford loan program. Another provision enables parents to defer repayments under some conditions. The bill also enables the U.S. Education Department to purchase student loans from lenders, thus providing liquidity to the market.
In a move that reassured the markets, student lender Sallie Mae announced plans to keep making federally guaranteed student loans. "Things are better today than they were [in the spring]," says Brett Lief, president at the National Council of Higher Education Loan Programs in Washington, D.C. "A lot of private lenders left the market but a few are putting their toes back in the water."
Glezerman agrees that worries about loan availability have eased. "In the last couple of months, we have gone 180 degrees," he says. But, at the same time, private lenders have tightened their credit policies and are taking a close look at credit scores. "Standards are increasing," says Glezerman. "Lenders want to mitigate their risk."
Whereas a lender last year might have required a 625 FICO score, he says, the lender now demands a 675 score. Other industry sources estimate that up to 30% of borrowers who would have been approved for loans last year will be disqualified this year.
Lenders are screening the default rates at certain schools. Some big banks are refusing to lend to two-year colleges because the students are considered a higher risk than those at four-year institutions. Professional schools, for-profit institutions and schools with low graduation rates are having trouble securing loans for their students. Even some less-selective four-year colleges are being singled out and dropped by lenders. "No one really knows if there will be loan shortfalls," says Justin Draeger, spokesperson at the National Association of Student Aid Administrators. "We think the steps have been taken to assure students have access to low cost loans, but we won't know [until the start of school season is assessed]."
Collections Impact
Colleges and universities are just starting to gauge the impact on collections. "As we issue bills for fall, then we will see the magnitude of the problem," says Glezerman. "We expect our bad debt expense to increase."
Enrolled students who cannot get loans possibly did not return to school, which will impact collections, he says.
Of course, the credit crunch and the lack of loan availability are intertwined with deteriorating economic conditions. "It's a double whammy," says Glezerman. He already sees evidence of rising defaults on tuition bills, though he expects that to be more pronounced later this year.
Student loan repayment usually is not a top priority with young people, says Heineman at Account Control Technology. "The cell phone bills and the car payments come first," she says.
Schools are bracing for a rough ride. "Things are going to get tougher," says Dennis DeSantis, associate vice chancellor for student financial services at the University of Pittsburgh. About 40% of the school's payments are linked to some type of student loan. Recoveries already have declined. The school has eight in-house collectors and also outsources collections to third-party agencies.
DeSantis, along with other school administrators, says it is difficult to judge collection performance because industry benchmarks are not available.
This fall, the National Association of College & University Business Officers plans to roll out a survey to collect data on 12 performance measures, such as the percentage of student accounts in collections. The data will be used to benchmark the efficiency of financial services.
Business: More or Less?
Despite turmoil in the student loan market, collection agencies have not seen an increase in business yet. The most recent default rate for federal student loans, as reported in 2007 by the Department of Education, was about 5%. Most observers expect placements to rise; however, bad debts will be more difficult to collect.
"We have not yet seen collection placements go up," says Damian at Windham. Defaults typically are not realized until after a student leaves school, and that could be years after the loans were originated.
But industry observers believe the market will shift. High gas and food prices, and a deteriorating labor market, will impact collections. "We expect defaults to rise," says Heineman. But she believes restrictions private lenders are placing on borrowers, such as requiring higher FICO scores, will make collecting those loans easier in years to come.
Weakening economic conditions will lead to more third-party collections work, adds Glezerman at Temple University. "There will be more defaults and more delinquencies," he says. "We will start to see defaults on tuition grow this fall."
Temple outsources collections 90-to-120 days after the student stops attending school. Like other schools, it does not collect private loans but does collect federal Perkins Loans, as well as tuition and fees.
Collection agencies should see growth from the student loan business, says Lief at the National Council of Higher Education Loan Programs, which represents both collection agencies and lenders. "Collection agencies are a full growth area," he says. But agencies report that margins are thin.
The Department of Education outsources its collections work and, Lief says, the fees have been reduced twice in the past two years.
Also, some private lenders have not returned to the market, which could mean agencies will lose those clients or there could be a reshuffling of customers. "It's certainly a risk," says Dan Calderon, president and CEO at Van Ru Credit Corp., a collection and call center firm in Des Plaines, Ill.
Van Ru offers a new lender product, a "welcome call." Agents contact student borrowers after graduation to update personal information. The agent provides information on how and where to make payments to prevent delinquencies. "The product has been a success with all types of lenders," says Calderon.
Schools are making their own adjustments to work with borrowers. At the University of St. Thomas, a small private school in Houston, rules are being eased so that students with late payments can still register next semester. The school sends debts to collection agencies only after the student is no longer enrolled. "We really try to work with the student," says Susan Rose, treasurer and director of student finances at the university.
A new rule under the CCRAA that took effect July 1 also is expected to impact collections. It caps collection costs that can be added to student loans at 30% for the first effort and 40% for the second effort and for litigated cases.
Schools are outsourcing more work and beefing up their internal departments, says Cynthia R. Schick, sales executive at Gila Corp., an Austin, Tex.-based agency that collects student loans. But, she says, as a relatively new player in the student loan market, it is harder to get new contracts because fewer private lenders are in the market. "There's only so much work to go around," says Schick.
Collection strategies are being retooled. Many families once had the option of tapping home equity loans to pay off outstanding student loans. But that route is becoming less available because of the downturn in the housing market.
Repayment plans are a popular collection strategy but some plans are no longer available. The federal loan consolidation program has "dried up" over the last year, says DeSantis at the University of Pittsburgh.
Under these programs, students could consolidate their loans at an attractive rate. If a borrower made nine consecutive payments, the loan was considered rehabilitated and resold as a performing loan.
Since consolidation plans are less available, collection agencies do not have a lot of options other than asking for an immediate payment, says Damian at collection firm Windham Professionals.
"The industry will survive," adds Damian, who previously worked for 35 years as the financial aid director and bursar at Northeastern University in Boston.
Colleges and universities still provide a worthwhile product that consumers want, he says, "But higher education needs to look at itself to bring costs down. Collection companies are willing to be partners in addressing these issues." CCR
